Thursday, March 10, 2011
8:54:07 PM EDT

A Revolting Development

by
Jim Brown

A potential revolt in Saudi Arabia and a shocking economic report out of China produced a buyer revolt in the U.S. equity markets.

Market Statistics

I don't even know where to start tonight. There are so many news events causing the market drop today I could write for hours and not get done. The big news before the open was a surprise announcement from China that they had a $7.3 billion trade deficit in February. That was the first monthly deficit since March 2010 and only the second in nearly seven years. This compares to a surplus in January of $6.45 billion and a surplus in Feb-2010 of +$7.61 billion.

This trade deficit was a major economic shock for traders already worried over a slowdown in China's economy. China has been hiking interest and reserve rates for months in an effort to control inflation and that has caused some worries over a renewed global slowdown.

China's custom officials said the timing of the lunar New Year, which fell in early February could have been the reason for the unexpected decline. A UBS analyst claimed this should not have been unexpected since producers ramp up to get products shipped before the New Year and then slump in the months that follow.

A Morgan Stanley economist claimed the trade data better reflected current conditions with exports rising +21.3% and imports up +36%. Almost everyone said despite the shock this would pass and China will still be the hottest economy on the planet.

The second major news event was the one notch downgrade of Spain's debt to Aa2 by Moody's. It was not the depth of the downgrade but the commentary that went along with it. Moody's cited worries over the cost of restructuring the banking sector, the government's ability to achieve borrowing reduction targets and grim economic growth prospects. Moody's warned it could cut the rating again is fiscal targets are missed and public debt continues to expand. Spain said its banking sector needs $21 billion in new capital. Twelve banks are considered under capitalized. FYI, Bill Gross is buying Spain's debt because they actually have a better balance sheet than the USA.

Earlier this week Moody's cut it's rating on Greece. These downgrades are a sign the debt crisis is heating up again. There is a crucial meeting on March 25th by EU leaders to discuss how to deal with Portugal and Ireland and the progress on the master EU bailout program. Portugal has spurned a potential bailout but the country had to pay 50% more (5.99% on 2-yr bonds) to sell debt on Wednesday than it did six months ago. Ten-year bonds have risen to 7%.

The sudden appearance of the EU debt crisis in the global news was another blow to an already weak U.S. equity market.

The market had started to rebound from the opening drop but at 12:30 news broke that Saudi Arabia had fired on a crowd of protestors in the city of Qatif and used stun grenades in an effort to breakup the protest. This would not have been that big of a deal in any other Arab country but Saudi has been relatively free of protests so far. However, protests are strictly forbidden and the government has taken extraordinary measures to prevent and control the planned Day of Rage protest on Friday. This protest could draw tens of thousands and news they fired on a couple hundred demonstrators on Thursday was not well received. Saudi Arabia produces 10% of the world's oil and Qatif is a major pipeline transit point to the world's largest oil terminal. If Saudi begins to experience civil unrest the oil infrastructure would be an easy target. There is no way the rest of the world can recover from a drop in Saudi production.

The government has mobilized 15,000 National Guard troops and 10,000 police to deal with the expected protest on Friday. They obviously plan on squashing it immediately despite calls from other nations to allow peaceful protests. King Abdullah tried to bribe citizens two weeks ago when he announced a stimulus package of $35 billion including raises for government employees and free tuition to school. The euphoria lasted about a week. Now the support for the protest is rising again.

When the Saudi news broke at 12:30 the rebounding market was knocked to the lows of the day with the Dow hitting 11,974 and a loss of -238. This drop was quickly bought but was immediately sold again as additional news about the Saudi altercation filtered out.

Oil prices had plunged on the China and Spain news with WTI hitting $100.62 intraday. The Saudi news caused a rebound to more than $104 but the broader market decline took hold and crude closed at $102.73. Brent is $115. With the potential for additional production cuts as protests spread, the price of crude is not likely to decline much in the days ahead until the fighting in Libya ends. In Libya the government is pressing the fight to the opposition and striking farther away from Tripoli and hitting positions harder using planes and artillery. Gaddafi appears to have ratcheted up the cost of opposition and he does not appear concerned about damage to oil installations.

Crude Oil Chart

Another minor factor in the early morning decline was the +26,000 spike in jobless claims to 397,000 for the week. Since claims had fallen significantly in the prior two weeks to a low of 371,000 (revised) it was not a real shock that we would have an eventual spike. Jobless claims are volatile with things like weather always a factor, as is a large layoff from several companies in the same week.

The Quarterly Services Survey showed year over year growth of +5.5% and higher than the 5.1% in Q3. That was as low as 2.6% back in 2010Q1. Professional, scientific and technical services increased at a 6.6% rate. Health care rose by +4.4%.

The economic reports due out on Friday are Consumer Sentiment, Business Inventories, Retail Sales and Job Openings.

In stock news NetFlix soared +$7 to close over $200 after the NetFlix Chief Content Officer downplayed the impact of Facebook and Time Warner on their business. When Facebook said earlier this week they were going to partner with Time Warner to stream videos on Facebook the shares of NetFlix declined sharply. Goldman said this was a credible threat and that weighed on NFLX shares. However, when the CCO called the threat no worse than any other competitor because nobody is going to routinely go to Facebook to watch a video. The stock gained strongly on the news despite the negative market. This was probably due to the heavy short interest reacting to the news.

NetFlix Chart

An even bigger gain was seen in shares of Green Market Coffee Roasters (GMCR) of +18. That is a +41% gain in one day. The power behind this move was a deal announced by GMCR and Starbucks to market Starbucks coffee and Tazo tea in the Keurig K-Cup portion packs. This deal had been speculated for sometime but over the last couple of weeks there were signs Starbucks might have been proceeding towards marketing its own single cup brewing machine to compete with GMCR. Actually Thursday's deal does not prevent Starbucks from marketing its own machine in the future. This may have been self-defense by Starbucks because Dunkin Donuts announced last month it was also joining the K-Cup line. Beginning this fall, the Starbucks K-Cup portion packs will be sold at supermarkets, wholesale clubs, drug stores, and department stores throughout the U.S. and Canada. This deal could also boost sales of the GMCR Keurig brewer. Starbucks said research showed more than 80% of current Starbucks customers do not yet own a single cup brewer. GMCR K-Cup sales rose +103% in 2010. Starbucks recently announced a deal with Courtesy that gave them a single serve solution in more than 500,000 hotels.

GMCR Chart

Starbucks Chart

The morning drop in crude prices made the energy sector the biggest loser for the day. With crude holding at $105 for the last week it was due for a pause. However, the amount of decline was significant. For instance Exxon Mobil (XOM) declined -$3 and that knocked $15 billion off its market cap. It is highly unusual for a highly liquid big cap stock with five billion shares outstanding to take this kind of hit. This kind of decline was sector wide so it was obviously the wholesale dumping of energy ETFs that caused the damage. With funds and hedge funds increasingly turning to ETFs for sector exposure the volatility can be huge. Instead of buying a million shares each in 15 stocks they can buy 15 million shares of an ETF. Unfortunately when they decide to liquidate that position it forces selling in the entire sector. They can't sell just Exxon or Conoco; they have to sell the entire ETF.

The dollar rallied to a two week high on the problems in the EU and the rising unrest in the Middle East. This would normally push commodities higher but the selling fever was broad based with metals and commodities of all flavors taking a dive. Copper is off about 8% from its highs and Gold was down about $35 from its highs at today's low of $1403.

Bonds had a great day. The auction for 30-year bonds today was given an A+ rating with a bid to cover ratio of 3.02 and a yield of 4.569%. The BTC average of the ten prior 30-year auctions was only 2.66. Rick Santelli said this was the strongest 30-year auction since August 2000. Fear about the return of the EU credit crisis and worry over China and the unrest in the Middle East had buyers in full flight to the safety of bonds.

Wednesday was the lowest volume since Feb 25th at 6.97 billion shares but Thursday added over two billion shares to 8.99 billion. Sharp declines always have more volume because of triggered stop losses and forced margin selling. Decliners were 7:1 over advancers and new 52-week highs at 77 were the lowest since November 17th. Despite the negative internals this was not yet at levels that would classify as a capitulation event.

The S&P retreated to critical support at 1295 at the open and again after the Saudi news. That is exactly where it closed and in theory it should be a critical inflection point for Friday. The Libyan low was 1294 back on Feb 24th. The Egyptian low was 1275. We could conceivably retest the Egyptian low and recover but I believe a break of 1295 could be very detrimental and lead to a much larger decline.

However, despite the commentators blaming China, Spain and Saudi Arabia today I think the real culprit is still the FOMC meeting coming up on Tuesday. The market has been listless all week as hedge funds rotated out of positions ahead of what they believe will be a change in the Fed's position. It was on the backdrop of these liquidations that the bad news today caused the market reaction.

I think it could have been worse and the halt at 1295 is a key point. The 8.9 billion shares is higher than we have seen in recent weeks but it is far below a real capitulation type of day with 10-12 billion shares. Buyers are still showing up at critical support levels and that is a key point.

Unfortunately the leftover sentiment from today will sour the Asian markets overnight and could carry over into our market on Friday. Fortunately Saudi Arabia is half a world away so we will have any news about their Day of Rage protest before our markets open on Friday. The protests are expected to start around 4:PM Saudi time, 8:AM ET. Facebook pages claim Saudi police are going to refuse to open fire on the protestors because supposedly the police are supportive of the movement. That may be why Saudi has activated the 15,000 National Guard troops. Saudi has a high personal ownership of firearms. More than 80% of families own weapons and some believe as many as 50% are AK-47s.

Either way we should have a clue as to the direction of the protest and the direction of our markets before the open. If the S&P opens below 1295 and stays there for more than a few minutes I would expect the selling to increase. We still have fear of the Fed until Tuesday afternoon and we definitely will have fear of darkness towards the close. Unless there is a giant rebound in progress late in the afternoon I would expect weekend event risk to keep buyers from bargain hunting. This is going to be a heavily event laden weekend overseas.

S&P-500 Chart

The Dow declined -228 points to close at 11,984 and just barely above the low from Feb-24th at 11,983. I know, talking about a one-point difference on a 12,000-point index is ridiculous but history is important in technical analysis. I would be very surprised if the Dow held its ground given the weekend event risk so that makes the next critical support level 11,800 and the lows from the Egyptian market drop. That would be a slid break of the 50-day average and a new four-week low. That is bearish in any context and the FOMC meeting is still two days away.

Dow Chart

The Nasdaq closed at a six week low and clearly below initial support. This is a major failure for the Nasdaq and suggests we will see a retest of critical support at 2675. Big cap techs are being sold hard and stocks like Google (GOOG -11.47) have broken below support. Google has declined -$50 in the last three weeks.

I see the Nasdaq as the leading indicator tonight. The Dow, S&P and Russell all closed at support but the Nasdaq failed. This could be an ugly omen ahead of the weekend's event risk.

Nasdaq Chart

The Russell managed to close about its late February support lows at 795 but it was the biggest loser of the day with a -2.6% drop. The Russell is not being sold alone as evidenced by the big cap news I reported earlier. Therefore I don't see it as a major indicator for Friday. Certainly a drop below 795 would be bearish but the other indexes are likely to crack first.

Russell Chart

I have no bullish thoughts for tonight. The markets closed bearish and barely on support. Our fate depends on the FOMC, Libya and the morning's events in Saudi Arabia. If Saudi switches posture and allows peaceful protests then it is possible we could see a rally. If they come down hard on the protestors it could spark even bigger and more violent protests later or civil disobedience and a production halt on oil. Higher oil prices would weigh on the market and the Fed. This weekend has significant event risk and I would be surprised if we finish higher on Friday. There is the potential for another monster short squeeze but that would require a major piece of bullish news. I would be careful taking a long position ahead of the FOMC announcement but I plan on buying energy stocks on the dip.

I would continue to be cautious until after the FOMC meeting next Tuesday. Tighten up your stops and exit aggressively to maintain any profits.